U.S. Companies Must Reveal How Much CEOs Earn Compared To Workers

Five years ago, the Dodd-Frank financial reform legislation directed the Securities and Exchange Commission to come up with rules requiring American companies to calculate and report the ratio between a CEO’s pay and that of the company’s typical employee. After repeated delays and claims from big business that the math was too complicated, the SEC has finally voted to approve these rules.

Section 953(b) of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act [PDF] adds a requirement that companies disclose “the median of the annual total compensation of
all employees of the issuer, except the chief executive officer (or any equivalent position) of the issuer; the annual total compensation of the chief executive officer… and the ratio of the amount.”

But the act provides no explanation of exactly how this ratio is to be calculated, resulting in years of delays as lawmakers, consumer and investor advocates, regulators, and big business groups debated the feasibility and utility of this information.

After receiving hundreds of thousands of comments from the public on this issue, the SEC finally voted to approve the rule and provide details on how it addresses concerns raised about the complexity and costs associated with the requirement.

Rather than prescribe a specific format for companies to calculate the CEO-worker pay ratio, the SEC has built in flexibility that gives employers the ability to use any “reasonable method” that “works best for their own facts and circumstances.”

Thus, a company with many thousands of employees spread around the nation can use sampling and estimates to calculate its ratio. However, businesses must describe and detail their methodologies for obtaining their final figures.

Additionally, rather than requiring companies to run the numbers every year, they will only be made to disclose the ratio every three years — except in cases where there have been significant changes to employee numbers or pay structure.

Companies with non-U.S. employees get a bit of a reprieve. Those with a small number of workers outside the country may not have to include their income. Likewise, those companies who claim that disclosing foreign employees’ earnings will violate foreign nation’s privacy laws may not have to include this pay in their ratios.

One area in which the final rule is not giving flexibility to companies is the definition of “employee.” Rather than simply calculating full-time workers, the ratio must also include part-time and seasonal staff.

As expected, the vote on the pay ratio rule was divide along party lines, with the Commission’s two conservative commissioners voting against the version presented today.

Commissioner Michael Gallagher has long been critical of the pay-ratio rule, calling it “maybe the most useless of all our Dodd-Frank mandates” which warranted the “caboose treatment,” referring to the years-long delay in approving the rule.

Gallagher questioned the usefulness of the rule, which is presented as being beneficial to investors who can use it to determine whether CEOs are being paid properly. Instead, he joined those opponents who believe the rule’s purpose is simply to embarrass and shame companies.

That said, Gallagher today acknowledged that Section 953(b) is the law of the land and that it’s the SEC’s job to draft the rule. However, he said the only way in which he would have supported such a rule was if it only applied to the pay for full-time employees in the U.S.